29 guidance notes

8/13/2019 29 Guidance Notes

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Accounting Treatment For Excise Duty

The following is the text of the revised Guidance Note on Accounting Treatment

For Excise Duty issued by the Institute of Chartered Accountants of India

INTRODUCTION

1. The Institute of Chartered Accountants of India, had issued a Guidance Note onAccounting Treatment for Excise Duties m 1979. In order to bring uniformit in the

accounting treatment of excise dut and in!entor !a"uation, the Guidance Note #as re!isedin 19$$. %ee&ing in !ie# further de!e"o&ments, !i'., issuance of the re!ised Accounting

(tandard )A(* +, -a"uation of In!entories )#hich has come into effecting res&ect ofaccounting &eriods commencing on or after 1..1999 and is mandator in nature*, it has

been decided to re!ise this Guidance Note again. This re!ised Guidance Notes being issuedin su&ersession of the ear"ier Guidance Note issued in 19$$ and is effecti!e in res&ect of

accounting &eriods beginning on or after A&ri" 1, 1999.

+. This Guidance Note recommends accounting treatment for Excise Dut in res&ect of

excisab"e goods &roduced or manufactured b an enter&rise. A se&arate Guidance Note onAccounting Treatment for /0D-AT sets out &rinci&"es for accounting for /0D-AT )no#

renamed as CEN-AT2.

3. At the outset, this Guidance Note brief" dea"s #ith norma"" acce&ted accounting

&rinci&"es for in!entor !a"uation as &rescribed in re!ised Accounting (tandard )A(* +4-a"uation of In!entories5 issued b the Institute of Chartered Accountants of India, and

nature of excise dut 6or detai"s, reference shou"d be made to re!ised Accounting (tandard)A(* + and Centra" Excise Act, u"es, Notifications and Circu"ars.

Normally Accepted Accounting Principles For Inventory aluation

. Norma"" acce&ted accounting &rinci&"es #ith regard to the !a"uation of in!entories )i.e.

materia"s or su&&"ies to be consumed in the &roduction &rocess or in the rendering ofser!ices, #or8in&rocess and finished goods*, as &rescribed in re!ised Accounting (tandard

)A(* +,-a"uation of In!entories, are re&roduced be"o#:

;. In!entories shou"d be !a"ued at the "o#er of cost and net rea"isab"e !a"ue.


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Norma" ca&acit is the &roduction ex&ected to be achie!ed on an a!erage o!er anumber of &eriods or seasons under norma" circumstances, ta8ing into account the

"oss of ca&acit resu"ting from &"anned maintenance. The actua" "e!e" of &roductionma be used if it a&&roximates> norma" ca&acit. The amount of fixed &roduction

o!erheads a""ocated to each unit of &roduction is not increased as a conse=uence of"o# &roduction or id"e &"ant. ?na""ocated o!erheads are recognised as an ex&ense in

the &eriod in #hich the are incurred. In &eriods of abnorma"" high &roduction, theamount of fixed &roduction o!erheads a""ocated to each unit of &roduction isdecreased so that in!entories are not measured abo!e cost. -ariab"e &roduction

o!erheads are assigned to each unit of &roduction on the basis of the actua" use of

the &roduction faci"ities.

511. 0ther costs are inc"uded in the cost of in!entories on" to the extent that theare incurred in bringing the in!entories to their &resent "ocation and condition. 6or

exam&"e, it ma be a&&ro&riate to inc"ude o!erheads other than &roduction

o!erheads or the costs of designing &roducts for s&ecific customers in the cost ofin!entories.5

Nature O! Excise Duty

;. Excise dut is a dut on manufacture or &roduction of excisab"e goods in India. (ection 3

of the Centra" Excise Act> 19, dea"s #ith charge of Excise Dut This (ection &ro!ides that

a dut of excise on excisab"e goods #hich are &roduced or manufactured in India sha"" be"e!ied and co""ected in such a manner as ma be &rescribed. This &rescri&tion is continued

in the Centra" Excise u"es, 19 #hich &ro!ide that excise dut sha"" be co""ected at the

time of remo!a" of goods from factor &remises or from a&&ro!ed &"ace of storage )u"e9*. ate of dut and tariff !a"uation to be a&&"ied is the one in force on that date, ie., the

date of remo!a" )u"e 9A* and not the date of manufacture. This difference in the &oint oftime bet#een taxab"e e!ent, !i'., manufacture and that of its co""ection has been examined

and discussed in a number of @udgements. 6or instance, the (u&reme Court m the case ofa""ace 6"our /i""s Co. Btd. !s. CCE 119$9 )* EBT ;99 summed u& the "ega" &osition as

under:

4It is #e"" sett"ed b the scheme of the Act as c"arified b se!era" decisions that e!en though

the taxab"e e!ent is the manufacture or &roduction of an excisab"e artic"e, the dut can be"e!ied and co""ected at a "ater stage for administrati!e con!enience. The (cheme of the said

Act read #ith the re"e!ant ru"es framed under the Act &articu"ar" u"e 9A of the said ru"es,re!ea"s that the taxab"e e!ent is the fact of manufacture of &roduction of an excisab"e

artic"e, the &ament of dut is re"ated to the date of remo!a" of such artic"e from thefactor.5

(u&reme Court in another case, !i'., CCE !s. -a'ir (u"tan Tobacco Co. 199< )$3* EBT 3he"d as under:

4e are of the o&inion that (ection 3 cannot be read as shifting the "e! from the stage ofmanufacture or &roduction of goods to the stage of remo!a". The "e! is and remains u&on

the manufacture or &roduction a"one. 0n" the co""ection &art of it is shifted to the stage of

remo!a".


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ma re"ate to a manufacturer, e.g., a sma"" sca"e industria" unit. Exem&tion ma be goodss&ecific, eg., handicrafts are current" #ho"" exem&t from dut. The exem&tion ma a"so be

enduse s&ecific, e.g., goods for use b defence ser!ices. Excisab"e goods can be remo!edfor ex&ort out of India either #ho"" #ithout &ament of dut or under bond or on &ament

of dut under c"aim for rebate of dut &aid.

7. Excisab"e goods, after com&"etion of their manufacturing &rocess, are re=uired to be 8e&t

in a storeroom or other identified &"ace of storage in a factor ti"" the time of their c"earance.Each such storeroom or storage &"ace is re=uired to be dec"ared to the Excise Authorities

and a&&ro!ed b them. (uch storeroom or storage &"ace is genera"" referred to as aonded (toreroom. Dutiab"e goods are a"so a""o#ed, sub@ect to a&&ro!a" of Excise

Authorities, to be remo!ed #ithout &ament of dut, to a onded arehouse outside

factor. In such cases, excise dut is co""ected at the time of c"earance of goods from suchonded arehouses.

$. Amount of excise dut forming &art of the sa"e &rice of the goods is re=uired to be

indicated se&arate" in a"" documents re"ating to assessment of dut, e.g., excise in!oice

used for c"earance of excisab"e goods )(ection 1+A*. It is, ho#e!er, o&en to a manufacturerto reco!er excise dut se&arate" or not to ma8e a se&arate reco!er but charge a

conso"idated sa"e &rice inc"usi!e of excise dut The incidence of excise dut is deemed to be

&assed on to the buer, un"ess contrar is &ro!ed b the &aer of excise dut )(ection 1+*.

Excise Duty As An Element O! Cost

9. In considering the a&&ro&riate treatment of excise dut for the &ur&ose of determinationof cost for in!entor !a"uation, it is necessar to consider #hether excise dut shou"d be

considered different" from other ex&enses.

1F. Admitted", excise dut is an indirect tax but it cannot> for that reason a"one, be treated

different" from other ex&enses. Excise dut arises as a conse=uence of manufacture ofexcisab"e goods irres&ecti!e of the manner of use dis&osa" of goods thereafter, e.g., sa"e,

destruction and ca&ti!e consum&tion. It does not cease to be a "e! mere" because the

same ma be remitted b a&&ro&riate authorit in case of destruction or exem&ted in casegoods are used for further manufacture of excisab"e goods in the factor. Tax )other than a

tax on income or sa"e* &aab"e b a manufacturer is as much a cost of manufacture as another ex&enditure incurred b him and it does not cease to be an ex&enditure mere"because it is an exaction or a "e! or because it is una!oidab"e. In fact, in a #ider context

an ex&enditure is an im&osition #hich a manufacturer #ou"d "i8e to minimise.

11. Excise dut contributes to the !a"ue of the &roduct. A dut &aid &roduct has a higher!a"ue than a &roduct on #hich dut remains to be &aid and no sa"e or further uti"isation of

excisab"e goods can ta8e &"ace un"ess the dut is &aid. It is, therefore, a necessar ex&ense

#hich must be incurred if the goods are to be &ut in the "ocation and condition in #hich thecan be so"d or further used in the manufacturing &rocess.

1+ Excise dut cannot therefore be treated different" from other ex&enses for the &ur&ose

of determination of cost for in!entor !a"uation. To do so #ou"d be contrar to the basic

ob@ecti!e of carring for#ard the cost re"ated to in!entories unti" these are so"d or

consumed.

13 As stated in &ara < abo!e, "iabi"it to excise dut arises e!en on excisab"e goods

manufactured and used in further manufacturing &rocess. In such a case excise dut &aid )if

the same is not exem&ted* on the intermediar &roduct becomes a manufacturing ex&ense.Excise dut &aid on such intermediar &roducts must, therefore, be inc"uded in the !a"uation

of #or8in&rocess or finished goods manufactures b the subse=uent &rocessing of such&roducts.

Provision For Unpaid Excise Duty


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1. (ince the &oint of time at #hich dut is co""ected is not necessari" the &oint of time at#hich the "iabi"it to &a the dut arises, situations #i"" often arise #hen dut remains to be

co""ected on goods #hich ha!e been manufactured. The most common of these situationsarises #hen die goods are stored under bond, i.e., in a bonded (tore oom, and the dut is

&aid #hen the goods are remo!ed from such bonded (tore oom.

1;. Di!ergent !ie#s exist as to #hether &ro!ision shou"d be made in the accounts for the

"iabi"it in res&ect of goods #hich are not c"eared or #hich are "ing in bond at the ba"ancesheet date.

1


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o&inion #hether the !a"uation of in!entories is fair and &ro&er in accordance #ith norma""acce&ted accounting &rinci&"es and is on the same basis, as in the ear"ier ears. If there is

an change in the basis of !a"uation, the effect of such change, if materia", is to bere&orted.

+1. As ex&"ained in this Guidance Note, the "iabi"it for excise dut arises at the &oint oftime at #hich the manufacture is com&"eted. The excise dut &aid or &ro!ided on finished

goods shou"d, therefore, be inc"uded in in!entor !a"uation. (imi"ar", excise dut &aid on&urchases )other than those subse=uent" reco!erab"e b the enter&rise from the taxing

authorities* as #e"" as intermediar &roducts used for manufacture shou"d a"so be inc"udedin the !a"uation of #or8in&rogress or finished goods.

++. If the method of accounting for excise dut is not in accordance #ith the &rinci&"esex&"ained in this Guidance Note, the auditor shou"d =ua"if his re&ort. In the case of a

com&an, reference to this =ua"ification shou"d a"so be made in the auditors re&ort under(ection ++7)A* of the Com&anies Act, 19;


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earned during the &eriod or the benefits of #hich do not extend beond that &eriod. Theex&ression cost means the amount of ex&enditure incurred on or attributab"e to a

s&ecified artic"e, &roduct or acti!it.

+. Ex&enses are recognised b the fo""o#ing a&&roaches:

(a) Identification with revenue transactions

Costs direct" associated #ith the re!enue recognised during the re"e!ant &eriod areconsidered as ex&enses and are charged to income for the &eriod.

(b) Identification with a period of time

In man cases, a"though some costs ma ha!e connection #ith the re!enue for the&eriod, the re"ationshi& is so indirect that it is im&racticab"e to attem&t to estab"ish it.

Ko#e!er, there is a c"ear identification #ith a &eriod of time.1 (uch costs areregarded as &eriod costs and are ex&ensed in the re"e!ant &eriod, e.g, sa"aries,

te"e&hone, tra!e""ing, de&reciation on office bui"ding, norma" interest, etc. (imi"ar",the costs the benefits of #hich do not c"ear" extend beond the accounting &eriod

are a"so charged as ex&enses.

3. The fo""o#ing features of ex&enses affect the nature, timing and extent of the re"ated

audit &rocedures:)a* In the case of most items of ex&enses, documentar e!idence originating from

third &arties is a!ai"ab"e.

)b* The nature and re"ati!e significance of !arious items of ex&enses usua"" differ

from one enter&rise to another, de&ending &rimari" on the nature of o&erationscarried out b them. 6or exam&"e, in the case of most manufacturing enter&rises, the

&rinci&a" items of ex&enses #ou"d inc"ude the cost of ra# materia"s consumed, "abourcost and other con!ersion costs. 0n the other hand in the case of a trading

enter&rise, the &rinci&a" items of ex&enses #ou"d genera"" be the cost of goods so"d.In the case of an enter&rise su&&"ing, &ro!iding, maintaining and o&erating an

ser!ices, the &rinci&a" items of ex&ense #ou"d inc"ude &ersonne" and &rofessiona"ex&enses, office maintenance, etc.

)c* The amount of some ex&enses has a "ogica" re"ationshi& #ith certain otherfinancia" statement items #hi"e the amount of some other ex&enses does not ha!e

such a re"ationshi&. 6or exam&"e, in an enter&rise #here the &roduction &rocess isstandardised, the consum&tion of ra# materia"s )and, therefore, the cost of ra#

materia"s consumed* has a "ogica" re"ationshi& #ith the =uantum of out&ut. (imi"ar",the &ro&ortion of !arious constituents of cost of &roduction is ex&ected to remain

more or "ess constant in the absence of 8no#n conditions to the contrar. Bi8e#ise,&ro&ortion of the amount of interest for a &eriod to the amount of "oans outstanding

during the &eriod is ex&ected to !ar #ithin certain s&ecific Emits. 0n the otherhand, the ex&enditure on research and de!e"o&ment often has "itt"e re"ationshi& #ith

other items in the financia" statements.

)d* The amount of some items of ex&enses )e.g., gratuit, taxes, bonus, etc.* is

significant" affected b a&&"icab"e "a#s.

. In an audit, the auditor em&"os a&&ro&riate &rocedures to obtain reasonab"e assurance

about !arious assertions )see (AJ ;, Audit Evidence). In carring out an audit of ex&enses,the auditor is &articu"ar" concerned #ith obtaining sufficient a&&ro&riate audit e!idence to

corroborate the managements assertions regarding the fo""o#ing:

0ccurrence that recorded ex&enses arose from transactions or e!ents #hich too

during the re"e!ant &eriod and &ertain to the entit.
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Com&"eteness that there are no unrecorded ex&enses.

/easurement that ex&enses are recorded in the &ro&er amounts and are a""ocated

&ro&er &eriod.

Jresentation and

Disc"osure

that ex&enses are disc"osed, c"assified, and described in accordanc

recognised accounting &o"icies and &ractices and re"e!ant statutor merits, if an.

;. In !ie# of the di!ergence in the nature of ex&enses incurred b different enter&rises, it isnot &ossib"e to describe the audit &rocedures a&&"icab"e in carring out an audit of ex&enses

in a"" situations. This Guidance Note &ro!ides guidance on &rocedures to be em&"oed in

carring out an audit of ex&enses #hich #ou"d be a&&"icab"e in the case of most enter&rises.It is recognised, ho#e!er, that audit &rocedures different from or additiona" to those

described in this Guidance Note ma be necessar in a &articu"ar case de&ending u&on its

s&ecific facts and circumstances.

INTERNA& CONTRO& EA&UATION


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C.I.6. basis, or 6.0.. basis, or some other basis.

)c* The auditor shou"d examine that im&orts for #hich consideration is &aab"e in a

foreign currenc are recorded at an a&&ro&riate amount in accordance #ithAccounting (tandard )A(* 11, Accounting for the Effects of Changes in oreign

E!change "ates.

+F. In addition to the audit &rocedures discussed abo!e, the fo""o#ing ana"tica" &roceduresma often be he"&fu" as a means of obtaining audit e!idence regarding the !ariousassertions re"ating to &urchases.

)a* Com&arison, item#ise and "ocation#ise both =uantit and !a"ue, of &urchasesfor the current ear&eriod #ith the corres&onding figures for &re!ious ears&eriods.

)b* Com&arison of ratio of gross margin to sa"es for the current ear&eriod #ith thecorres&onding figures for &re!ious ears&eriods.

)c* Com&arison of ratio of &urchase returns to Jurchases for the current ear&eriod#ith the corres&onding figures for &re!ious ears&eriods.

)d* Jroduct#ise reconci"iation of =uantit so"d during the ear&eriod #ith o&eningstoc8, &urchases&roduction and c"osing stoc8.

A&art from the abo!e, the auditor ma a"so #or8 out =uantitati!e ratios and reconci"iations,e.g., he ma re"ate the =uantum of out&ut to the =uantum of in&ut to @udge its

reasonab"eness. In case segment information is a!ai"ab"e, the abo!e &rocedures ma becarried out for each segment.

+1. The auditor shou"d a"so !erif &aments subse=uent to the date of the ba"ance sheet toidentif an &urchases #hich ha!e not been recorded in the boo8s of account.

,ages and $alaries

++. The auditor shou"d examine the entries in the &aro""#age sheets #ith reference to

re"e!ant records, e.g., em&"oees records maintained b the &ersonne" de&artment sho#ingdetai"s of &a such as basic &a, a""o#ances, annua" increments, "ea!es a!ai"ed, etc. (&ecia"

attention ma a"so be &aid b auditor in res&ect of ne# em&"oees @oining the entit during

the ear. (imi"ar", the &aro"" ma a"so be examined #ith reference to the timerecordsattendance records and "ea!e records maintained b the &ersonne" de&artment. Thedeductions made in res&ect of incometax, &ro!ident fund, Em&"oees (tate Insurance

)E(1*, #e"fare schemes, hea"th schemes, etc. ma be examined #ith reference to thereturns submitted to the authorities concerned and the recei&tsac8no#"edgments issued b

such authorities.

+3. The auditor shou"d examine #hether an "ega", regu"ator or contractua" re=uirements

ha!ing a bearing on the rate or amount of #ages and sa"aries ha!e been com&"ied #ith.(imi"ar considerations #ou"d a"so a&&" to &aments made to a contractor for hire of "abour.

(uch re=uirements #ou"d inc"ude, inter a"ia, the &ro!isions of the /inimum ages Act,19$, agreement #ith the em&"oees, a#ard of com&etent authorit and @udicia" ru"ings.

+. In the case of senior management officia"s, the auditor shou"d &a &articu"ar attention

to determining #hether the sa"aries &aab"e are as &er the terms of contract #ith theem&"oees concerned. (&ecia" re=uirements of terms of contract such as granting stoc8o&tions )as &er schemes formu"ated b (E1*, a!ai"ing "ea!e encashment, tota" amount

&aab"e annua"" inc"uding exgratia, etc. shou"d be s&ecifica"" "oo8ed into.

+;. In the case of casua" "abour, besides carring out the other audit &rocedures, the auditor

shou"d s&ecifica"" examine the sanction of the com&etent authorit for em&"oment of such"abour and ascertain #hether such em&"oees are retained as &er the time rate or &iecerate

basis. In a&&ro&riate cases, the auditor ma &a a sur&rise !isit to the sites #here the


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casua" "abour is em&"oed to assess the correctness of the attendance records maintained inres&ect of such "abour. In cases #here com&"ete outsourcing of "abour has been gi!en to an

outside agenc, the term of agreement and com&"iance thereof #ou"d be examined.

+

)f* com&arison of the ratio of contribution to#ards &ro!ident fund to #ages andsa"aries for the current ear&eriod #ith the corres&onding figures for &re!ious

ears&eriods>

)g* com&arison of the ratio of contribution to#ards &ro!ident fund to #ages and

sa"aries for the current ear&eriod #ith the rate)s* of contribution s&ecified underthe "a# go!erning &ro!ident fund>

)h* com&arison of the ratio of contribution to#ards E(I to #ages and sa"aries for the

current ear&eriod #ith the corres&onding figure for &re!ious ears&eriods>)i* com&arison of the ratio of contribution to#ards E(I to #ages and sa"aries for thecurrent ear&eriod #ith the rate)s* of contribution s&ecified under the "a# go!erning

the E(I.

-onus

+$. In the case of &ro!ision for bonus, the auditor shou"d examine #hether the "iabi"it is

&ro!ided for in accordance #ith the Jament of onus Act, 19


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case the entit has not obtained such an actuaria" certificate, the auditor shou"d examinethat the method fo""o#ed b it, sa, grou& gratuit insurance scheme ta8en b the entit, for

ca"cu"ating the accrued "iabi"it for gratuit is rationa".

Ot+er Conversion Costs

3F. The auditor shou"d !erif the other con!ersion costs )such as &o#er and fue", &rocessing

charges, etc.* #ith reference to the su&&orting documents and re"ated agreements. In casethe materia" is sent outside to third &arties for &rocessing, necessar charges inc"uding existence of materia"s, #astage, etc. need to be ascertained and accounted for. In addition, the

auditor ma a"so com&are the amount of ex&ense on a &articu"ar item #ith thecorres&onding figure for &re!ious ears. (imi"ar", he ma #or8 out the ratios of different

items of con!ersion costs to tota" cost of &roduction for the current ear and com&are thesame #ith the corres&onding figures for &re!ious ears.

Esta#lis+ment and %eneral Administrative Expenses

31. The auditor shou"d !erif estab"ishment ex&enses and genera" administrati!e ex&enses

such as insurance, rent, rates, con!eance, tra!e""ing, te"e&hone, entertainment, &rintingand stationer, genera" ex&enses, etc. #ith reference to the sanction of the com&etent

authorit, the su&&orting documents, re"ated agreements and the ru"es and regu"ations

fo""o#ed b the entit. The auditor ma a"so com&are the amounts of these ex&enses #iththe corres&onding figures for &re!ious ears. (imi"ar", he ma #or8 out the ratios ofdifferent items of ex&enses to sa"es for the current ear and com&are the same #ith the

corres&onding figures for &re!ious ears.

Interest and Financial c+arges

3+. The auditor shou"d !erif the amount of interest ex&ense for the ear #ith reference tothe terms and conditions of re"e!ant agreements. The auditor ma a"so #or8 out the ratio of

interest ex&ense for the ear to a!erage interestbearing "oans and ad!ances outstandingduring the ear and com&are it #ith the corres&onding figure for &re!ious ears and

reconci"e the same. The auditor shou"d &articu"ar" examine that interest as #e"" as otherfinancing costs such as commitment fees on funds borro#ed for a =ua"ifing asset inc"uded

in the gross boo8 !a"ue of the asset to #hich the re"ate and ha!e not been charged to the

&rofit and "oss account of the &eriod in #hich the are incurred $. If the entit has &aid an&ena" interest it shou"d a"so be examined. (uch interest shou"d be disc"osed as &art of

norma" interest. The auditor shou"d consider, ha!ing regard to the materia"it, #hether itre=uires se&arate disc"osure.

Depreciation

33. The auditor shou"d chec8 the ca"cu"ation of de&reciation. The tota" de&reciation arri!edat shou"d be com&ared #ith that of &re!ious ears to identif reasons for !ariations. The

auditor shou"d &articu"ar" examine #hether the de&reciation charge ha!ing regard to rateof de&redation and method of de&reciation fo""o#ed consistent" is ade=uate 8ee&ing in !ie#

the genera"" acce&ted bases of accounting for de&reciation9. A"ternati!e", the auditor ma

consider =ua"ifing his re&ort. In case, assets ha!e been re!a"ued b entit during the ear,the auditor shou"d ensure that the de&reciation has been com&uted &ro&er".

Researc+ and Development Expenses

3. The auditor shou"d !erif !arious items of ex&enses incurred on research andde!e"o&ment #ith reference to su&&orting documents and re"ated agreements. 6or exam&"e,

the cost of materia"s consumed for research and de!e"o&ment ma be !erified #ithreference to such documents as &urchase in!oices, goods recei!ed notes, records re"ating to

issue of materia"s, etc. The auditor shou"d &articu"ar" examine #hether the accounting &o"ic fo""o#ed b the entit regarding treatment of research and de!e"o&ment costs is in

accordance #ith Accounting (tandard )A(* #, Accounting for "esearch and $evelopment.
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1. The auditor shou"d obtain from the management a statement sho#ing the status of&ending tax matters. Ke shou"d examine the statements to assess the ade=uac of

&ro!isions made in res&ect of those matters in the context of their current status.

$PECIA& CON$IDERATION$ IN T.E CA$E OF A CO*PAN/

+. In the case of audit of a com&an, in addition to the &rocedures described abo!e, the

auditor shou"d a"so carr out a&&ro&riate audit &rocedures in res&ect of matters #hich ares&ecifica"" re=uired to be examined under the &ro!isions of the Com&anies Act, 19;


14/81

here the auditor is satisfied that &o"itica" contributions ha!e been made in excess of

the "imit &rescribed in section +93A, he shou"d bring this to the attention of theshareho"ders b =ua"ifing his audit re&ort and ma8ing a mention of the excess

amount in!o"!ed, if ascertainab"e.

The auditor shou"d obtain a certificate from com&ans board of directors to theeffect that a"" amounts of contributions to &o"itica" &arties or for an &o"itica" &ur&oseto an &erson fa""ing under the &ro!isions of section +93A ha!e been brought into the

boo8s of account of the com&an and that no amounts of such nature other than

those so inc"uded in the boo8s ha!e been &aidgi!en, direct" or indirect".

)d* The auditor shou"d examine #hether the contribution, if an, to the Nationa"Defence 6und or an other fund a&&ro!ed b the Centra" Go!ernment for the

&ur&ose of nationa" defence com&"ies #ith the &ro!isions of section +93O3 of the

Com&anies Act, 19;


15/81

3. The auditor shou"d satisf himse"f that the ex&enses ha!e been &ro&er" c"assified anddisc"osed in the financia" statements. here the re"e!ant statute "as do#n an disc"osure

re=uirements in this beha"f, the auditor shou"d examine #hether the same ha!e beencom&"ied #ith.

*ANA%E*ENT REPRE$ENTATION

. The auditor shou"d consider obtaining a management re&resentation on ex&ensescharged to the statement of &rofit or "oss #hen other sufficient a&&ro&riate audit e!idencecannot reasonab" be ex&ected to exist. 1

DOCU*ENTATION

;. The auditor shou"d maintain ade=uate #or8ing &a&ers regarding audit of ex&enses. 1;

1 eference ma be made in this regard to Guidance Note on Accrua" asis of Accounting.

+ The extent of re!ie# of interna" contro"s #ou"d de&end u&on the facts and circumstances

of each case. eference ma be made in this regard to the Interna" Contro" Puestionnaire,issued b the Institute of Chartered Accountants of India in 197< #hich contains, inter a"ia,

an i""ustrati!e "ist of interna" contro"s in re"ation to &ett cash, cash and ban8 &aments,sa"aries and #ages And &urchases.

3 efer to (AJ1, Ana"tica" Jrocedures

efer to A(1 $, e"ated Jart Disc"osures.

; efer to (AJ+1, Consideration of Ba#s and egu"ations in an Audit of 6inancia"

(tatements.

< Attention is in!ited in this regard to A( *, Accounting for "etirement 'enefits in the

inancial Statements of Emplo+ers.

7 Attention is a"so in!ited in this regard to (AJ 9, sing the -or of an E!pert.

$ Attention is in!ited A(1


16/81

the (AJs #here!er necessar.

+. The Auditing Jractices Committee has a"so ta8en u& the tas8 of re!ie#ing the (tatements

on auditing matters issued &rior to the formation of the Committee. It is intended to issue,in due course of time, (AJs or Guidance Notes, as a&&ro&riate, on the matters co!ered b

such (tatements #hich #ou"d then stand #ithdra#n. ith the issuance of this GuidanceNote on Audit of Cash and an8 a"ances, Cha&ter < of the (tatement on Auditing Jractices,

tit"ed Cash and an8 a"ances, sha"" stand #ithdra#n. +In due course of time, the entire(tatement on Auditing Jractices sha"" be #ithdra#n.

INTRODUCTION3. Cash and ban8 ba"ances ma constitute a significant &ro&ortion of the tota" assets of an

entit. An im&ortant feature of cash and ban8 ba"ances #hich has a significant im&act on there"ated audit &rocedures is that these assets are high" &rone to misa&&ro&riation,

misa&&"ication and other forms of fraud.

. In an auditing situation, the auditor em&"os a&&ro&riate &rocedures to obtain

reasonab"e assurance about !arious assertions )see (tatement of (tandard AuditingJractices Audit E!idence*. In carring out an audit of cash and ban8 ba"ances, the auditor is

&articu"ar" concerned #ith obtaining sufficient a&&ro&riate audit e!idence to corroboratethe management2s assertions regarding the fo""o#ing:

Existence H that recorded cash and ban8 ba"ances exist as at the earend.ights and ob"igations H that recorded cash and ban8 ba"ances re&resent the assets of the

entit.

Com&"eteness H that there are no unrecorded cash and ban8 ba"ances.

esides the abo!e, in certain situations, the auditors ma a"so be &articu"ar" concerned#ith the !a"uation of cash and ban8 ba"ances, e.g., in the case of )g* safe custod of cash,

foreign currenc he"d b the entit or in the case of ban8 accounts designated in foreigncurrencies.

INTERNA& CONTRO& EA&UATION;. The auditor shou"d stud and e!a"uate the sstem of interna" contro" re"ating to cash and

ban8 ba"ances to determine the nature, timing and extent of his other audit &rocedures. Keshou"d &articu"ar" re!ie# the fo""o#ing as&ects of interna" contro" re"ating cash and ban8

ba"ances. 3

)a* (egregation of duties re"ating to authorisation of transactions, hand"ing of cash

issuance of che=ues and #riting of boo8s of account, and rotation of the duties&eriodica"">

)b* &ro&er authorisation of cash and ban8ing transactions>

)c* dai" recording of cash transactions>

)d* safeguards such as restricti!e crossing of che=ues, use of &re&rinted, &renumbered forms>

)e* &eriodic reconci"iation of ban8 ba"ances>

)f* reconci"iation of cashonhand #ith boo8 ba"ance on a dai" basis or at other

a&&ro&riate inter!a"s, inc"uding sur&rise chec8s b higher authorities>

)g* safe custod of cash, che=ue boo8s, recei&t boo8s etc.> and

)h* cashfide"it insurance.

ERIFICATION


17/81

extent of substanti!e &rocedures to be &erformed is a matter of &rofessiona" @udgment ofthe auditor #hich is based, inter a"ia, on the auditors e!a"uation of the effecti!eness of the

re"ated interna" contro"s.

eri!ication o! Cas+ -alances

7. The auditor shou"d carr out &hsica" !erification of cash at the date of the ba"ance sheet.Ko#e!er, if this is not feasib"e, &hsica" !erification ma be carried out, on a sur&rise basis,

at an time short" before or after the date of the ba"ance sheet. In the "atter case, theauditor shou"d examine #hether the cash ba"ance sho#n in the financia" statements

reconci"es #ith the resu"ts of the &hsica" !erification after ta8ing into account the cashrecei&ts and cash &aments bet#een the date of the &hsica" !erification and the date of the

ba"ance sheet. esides &hsica" !erification at or around the date of the ba"ance sheet, the

auditor shou"d a"so carr out sur&rise !erification of cash during the ear.

$. A"" cash ba"ances in the same "ocation shou"d be !erified simu"taneous". here &ettcash is maintained b one or more officia"s, the auditor shou"d ad!ise the entit to re=uire

the officia"s concerned to de&osit the entire &ett cash on hand on the "ast da #ith the

cashier. The auditor shou"d en=uire #hether the cashier a"so hand"es cash of sister concerns,staff societies, etc. in such a case, cash &ertaining to them shou"d a"so be !erified at the

same time so as to a!oid chances of cash ba"ances of one entit being &resented as those of

another.

9. If I0?s )I o#e ou* or other simi"ar documents are found during &hsica" !erification,the auditor shou"d obtain ex&"anations from a senior officia" of the entit as to the reasons

for such I0?s other simi"ar documents remaining &ending. It shou"d a"so be ensured that

such I0?sother simi"ar documents are not sho#n as cashonhand.

1F. The =uantum of torn or muti"ated currenc notes shou"d be examined in the context ofthe si'e and nature of business of the entit. The auditor shou"d a"so examine #hether such

currenc notes are exchanged #ithin a reasonab"e time.

11. If, during the course of the audit, it comes to the attention of the auditor that the entit

is consistent" maintaining an undu" "arge ba"ance of cashonhand, he shou"d carr outsur&rise !erification of cash more fre=uent" to ascertain #hether the actua" cash on hand

agrees #ith the ba"ance as sho#n b the boo8s. If the cash on hand is not in agreement#ith the ba"ance as sho#n in the boo8s, he shou"d see8 ex&"anations from a senior officia" ofthe entit. In case an materia" difference is not satisfactori" ex&"ained, the auditor shou"d

state this fact a&&ro&riate" in his audit re&ort. In an case, he shou"d satisf himse"fregarding the necessit for such "arge ba"ances ha!ing regard to the norma" #or8ing

re=uirements of the entit. The entit ma a"so be ad!ised to de&osit the #ho"e or the ma@or&art of the cash ba"ance in the ban8 at reasonab"e inter!a"s.

1+. here &ost dated che=ues are on hand on the ba"ance sheet date, the auditor shou"d!erif that the ha!e not been accounted for as co""ections during the &eriod under audit.

eri!ication o! -an1 -alances

13. The auditor shou"d ad!ise the entit to send a "etter to a"" its ban8ers to direct" confirm

the ba"ances to the auditor. The A&&endix to this Guidance Note gi!es an i""ustrati!e

&roforma "etter of re=uest for confirmation to be used for this &ur&ose. The re=uest forconfirmation shou"d a"so co!er dormant accounts as #e"" as accounts c"osed during the ear.

1. The auditor shou"d examine the ban8 reconci"iation statement &re&ared as on he "ast

da of the ear. Ke ma a"so examine the reconci"iation statements as at other dates duringthe ear. It shou"d be examined #hether )i* che=ues issued b the entit but not &resented

for &ament, and )ii* che=ues de&osited for co""ection b the entit but not credited in theban8 account, ha!e been du" debitedcredited in the subse=uent &eriod. 6or this &ur&ose,

the ban8 statements of the re"e!ant &eriod shou"d be examined. If the che=ues issuedbefore the end of the ear ha!e not been &resented #ithin a reasonab"e time, it is &ossib"e


18/81

that the entit might ha!e &re&ared the che=ues before the end of the ear but notde"i!ered them to the &arties concerned. 1 n such a case, the auditor shou"d examine that

the entit has re!ersed the re"e!ant entries.

1;. here the auditor finds that &ost dated che=ues are issued b the entit, he shou"d

!erif that an che=ues &ertaining to the subse=uent &eriod ha!e not been accounted for as&aments during the &eriod under audit.

1


19/81

)a* Tem&orar ad!ances.

)b* (ta"e or dishonoured che=ues.

Jostage and re!enue stam&s, if materia" in amount, ma be sho#n se&arate" instead ofbeing inc"uded under cash and ban8 ba"ances.

+7. The auditor shou"d a"so examine that suitab"e disc"osures as mentioned in &aragra&hs

+F and + abo!e are made in re"e!ant cases.

AJJENDI

I&&U$TRATIE &ETTER OF CONFIR*ATION -AN2 -A&ANCE$

)ef. Jaragra&h 13*

Betterhead of Entit

Date

Name and Address of an8

Dear (irs,

J"ease send direct" to our auditors ........... )name and address of the auditors* detai"s of

ba"ances as at the c"ose of business on date QQQQQ of a"" our accounts #ith ou as #e""

as detai"s of charges he"d against such ba"ances, #ith a co& to us. 6or our con!enience,#e enc"ose in du&"icate a form in #hich detai"s of our ba"ances #ith ou can be fi""ed in. If

ou find the s&aces on the form insufficient to contain ai" the re"e!ant information, &"easeattach a se&arate statement.

J"ease note that this re=uest co!ers a"" our accounts #ith ou as at the abo!e mentioned

date, inc"uding an dormant accounts. e #ou"d a"so re=uest ou to gi!e &articu"ars of an

of our accounts c"osed during the ear. e #ou"d re=uest ou to state Ni"5, #here!era&&"icab"e.

Rours faithfu"",

)(ignature of &erson authorised to o&erate accounts*

e&" from )an8*

Date ..................

e: )Name of C"ient*

At the re=uest of our c"ient #e submit be"o# &articu"ars of their accounts, in!estments, bi""s,etc., as at the c"ose of business on Q.QQQ. as sho#n b our records

1 . Current Accounts in Credit:

Designation of Account

Amount

+. 0!erdra#n Current Accounts,0!erdraft Accounts, Cash Credit

Accounts


Amount (ecurit Ke"d )Gi!e briefdescri&tion. In the case of

securities &"ease "ist fu""*

3. Boan Accounts:


Amount (ecurit Ke"d )Gi!e brief

descri&tion. In the case ofsecurities &"ease "ist fu""*

. 6ixed, Ca"" and (hort De&osit

Accounts:

Due Date Jarticu"ars of an charges or "iens


20/81

Amount. Interest Accrued to theC"osing Date

;. In!estments and 0ther Documentsof Tit"e Ke"d in (afe Custod:

Designation

6ace -a"ue or number of shareshe"d


21/81

satisfied that, in the circumstances of the case, it ma not be necessar to do so.

+. The s&ecia" as&ects of audit of cash and ban8 ba"ances in the case of ban8s are dea"t #ith

in the Guidance Note on Audit of an8s issued b the Auditing Jractices Committee.

3. The extent of re!ie# of contro"s #ou"d de&end u&on the facts and circumstances of each

case. eference ma be made in this regard to the Interna" Contro" Puestionnaire, issued b

the Institute of Chartered Accountants of India in 197< #hich contains, inter a"ia, ani""ustrati!e "ist of interna" contro"s in re"ation to cash and ban8 ba"ances.

. 6or !a"uation of foreign currenc he"d as cash on hand and ban8 ba"ances designated in

foreign currencies, reference ma be made to Accounting (tandard 11, Accounting for theEffects of Changes in 6oreign Exchange ates, issued b the Institute of Chartered

Accountants of India

%uidance Note on Accounting !or Fringe -ene!its Tax

(he following is the te!t of the 0uidance 1ote on Accounting for ringe 'enefits a!,issued b+ the Council of the Institute of Chartered Accountants of India .)

1. The 6inance Act, +FF;, has introduced Cha&ter IIK on Incometax on 6ringeenefits2 hereinafter referred to as 6ringe enefits Tax2. The re"e!ant extracts from

Cha&ter IIK of the Incometax Act, 19


22/81

an association of &ersons or a bod of indi!idua"s, #hether incor&orated or not,but exc"uding an fund or trust or institution e"igib"e for exem&tion under

c"ause )+3C* of section 1F or registered under section 1+AA of the Act>

a "oca" authorit> and

e!er artificia" @uridica" &erson, not fa""ing #ithin an of the &receding subc"auses.

The term fringe benefits2 means an consideration for em&"oment &ro!ided b #a of

H

an &ri!i"ege, ser!ice, faci"it or amenit, direct" or indirect", &ro!ided b an

em&"oer, #hether b #a of reimbursement or other#ise, to his em&"oees)inc"uding former em&"oee or em&"oees*>

an free or concessiona" tic8et &ro!ided b the em&"oer for &ri!ate @ournes ofhis em&"oees or their fami" members> and

an contribution b the em&"oer to an a&&ro!ed su&erannuation fund forem&"oees.

The fringe benefits sha"" be deemed to ha!e been &ro!ided b the em&"oer to hisem&"oees, if the em&"oer has, in the course of his business or &rofession

)inc"uding an acti!it #hether or not such acti!it is carried on #ith the ob@ect ofderi!ing income, &rofits or gains*, incurred an ex&ense on or made an &ament

for the &ur&oses stated in section 11;)+* of the Act. Exam&"es of the &ur&osesstated under the said section are entertainment, festi!a" ce"ebrations, gifts,

maintenance of guest house, em&"oees2 #e"fare, hote", boarding and "odging,con!eance, tour and tra!e" )inc"uding foreign tra!e"*, etc.

E!er em&"oer #ho during a &re!ious ear has &aid or made &ro!ision for &ament offringe benefits to his em&"oees, is re=uired to furnish a return of fringe benefits to

the Assessing 0fficer in the &rescribed form, on or before the due date, in res&ectof the &re!ious ear.

6ringe enefits Tax, "i8e an other direct tax, is not an a""o#ab"e ex&enditure for the&ur&ose of com&utation of taxab"e income.

NATURE OF FRIN%E -ENEFIT$ TA0

3. ith a !ie# to recommend a &ro&er and uniform accounting treatment for the 6ringe

enefits Tax, it is necessar to understand the nature of 6ringe enefits Tax #hich isdiscussed in &aragra&hs .


23/81

. The 6ringe enefits Tax has been introduced under the Incometax Act, 19


24/81

se&arate", if materia".

9. %ee&ing in !ie# the abo!e, the 6ringe enefits Tax shou"d be disc"osed as a se&arateitem after determining &rofit before tax on the face of the &rofit and "oss account for the

&eriod in #hich the re"ated fringe benefits are recognised. An i""ustration of the disc"osure

of 6ringe enefits Tax ma be as be"o#:

Jrofit before tax xx

x

Bess: Incometax ex&ense:

Current tax xxx

Deferred tax xx

x

xx

x

6ringe enefits Tax xxx

xxx

Jrofit after tax xx

x

1F. The amount of the 6ringe enefits Tax )net of the ad!ance tax thereon*, outstanding ifan, at the earend, shou"d be disc"osed as a &ro!ision in the ba"ance sheet.

Annexure

T+e Relevant Extracts !rom C+apter 0II3. o! t+e Income3tax Act4 56754

%overning t+e Fringe -ene!its Tax

'For assessment year 899739:(

A.S/eaning of certain ex&ressions

De!initions

55;,


25/81

a firm>

an association of &ersons or a bod of indi!idua"s, #hether incor&orated or not,

but exc"uding an fund or trust or institution e"igib"e for exem&tion underc"ause )+3C* of section 1F or registered under section 1+AA>

a "oca" authorit> and

e!er artificia" @uridica" &erson, not fa""ing #ithin an of the &receding sub

c"auses>

4fringe benefit tax5 or 4tax5 means the tax chargeab"e under section 11;A.

.Sasis of charge

C+arge o! !ringe #ene!it tax

55;,A

an free or concessiona" tic8et &ro!ided b the em&"oer for &ri!ate @ournes of hisem&"oees or their fami" members> and

an contribution b the em&"oer to an a&&ro!ed su&erannuation fund for em&"oees.

The &ri!i"ege, ser!ice, faci"it or amenit does not inc"ude &er=uisites in res&ect of

#hich tax is &aid or &aab"e b the em&"oee.

)+* The fringe benefits sha"" be deemed to ha!e been &ro!ided b the em&"oer to hisem&"oees, if the em&"oer has, in the course of his business or &rofession )inc"uding an


26/81

acti!it #hether or not such acti!it is carried on #ith the ob@ect of deri!ing income,&rofits or gains* incurred an ex&ense on, or made an &ament for, the fo""o#ing

&ur&oses, name":S

entertainment>

&ro!ision of hos&ita"it of e!er 8ind b the em&"oer to an &erson, #hether b #aof &ro!ision of food or be!erages or in an other manner #hatsoe!er and #hether

or not such &ro!ision is made b reason of an ex&ress or im&"ied contract orcustom or usage of trade but does not inc"udeS

an ex&enditure on, or &ament for, food or be!erages &ro!ided b the

em&"oer to his em&"oees in office or factor>

an ex&enditure on or &ament through &aid !ouchers #hich are not

transferab"e and usab"e on" at eating @oints or out"ets>

conference )other than fee for &artici&ation b the em&"oees in an conference*.

Ex&"anation.S6or the &ur&oses of this c"ause, an ex&enditure on con!eance, tour

and tra!e" )inc"uding foreign tra!e"*, on hote", or boarding and "odging inconnection #ith an conference sha"" be deemed to be ex&enditure incurred for the

&ur&oses of conference>

sa"es &romotion inc"uding &ub"icit:

Provided that an ex&enditure on ad!ertisement,S

being the ex&enditure )inc"uding renta"* on ad!ertisement of an form in an

&rint )inc"uding @ourna"s, cata"ogues or &rice "ists* or e"ectronic media ortrans&ort sstem>

being the ex&enditure on the ho"ding of, or the &artici&ation in, an &ressconference or business con!ention, fair or exhibition>

being the ex&enditure on s&onsorshi& of an s&orts e!ent or an other e!entorganised b an Go!ernment agenc or trade association or bod>

being the ex&enditure on the &ub"ication in an &rint or e"ectronic media of annotice re=uired to be &ub"ished b or under an "a# or b an order of a

court or tribuna">

being the ex&enditure on ad!ertisement b #a of signs, art #or8, &ainting,

banners, a#nings, direct mai", e"ectric s&ectacu"ars, 8ios8s, hoardings, bi""boards or b #a of such other medium of ad!ertisement> and


27/81

being the ex&enditure b #a of &ament to an ad!ertising agenc for the&ur&oses of c"auses )i* to )!* abo!e,

sha"" not be considered as ex&enditure on sa"es &romotion inc"uding

&ub"icit>

em&"oees2 #e"fare.

Ex&"anation.S6or the &ur&oses of this c"ause, an ex&enditure incurred or &ament

made to fu"fi" an statutor ob"igation or mitigate occu&ationa" ha'ards or &ro!ide

first aid faci"ities in the hos&ita" or dis&ensar run b the em&"oer sha"" not beconsidered as ex&enditure for em&"oees2 #e"fare>

con!eance, tour and tra!e" )inc"uding foreign tra!e"*>

use of hote", boarding and "odging faci"ities>

re&air, running )inc"uding fue"*, maintenance of motor cars and the amount of

de&reciation thereon>

re&air, running )inc"uding fue"* and maintenance of aircrafts and the amount of

de&reciation thereon>

use of te"e&hone )inc"uding mobi"e &hone* other than ex&enditure on "eased te"e&hone"ines>

maintenance of an accommodation in the nature of guest house other than

accommodation used for training &ur&oses>

festi!a" ce"ebrations>

use of hea"th c"ub and simi"ar faci"ities>

use of an other c"ub faci"ities>

gifts> and

scho"arshi&s.

)3* 6or the &ur&oses of subsection )1*, the &ri!i"ege, ser!ice, faci"it or amenit does notinc"ude &er=uisites in res&ect of #hich tax is &aid or &aab"e b the em&"oee.

alue o! !ringe #ene!its


28/81

55;,C

actua" amount of contribution referred to in c"ause )c* of subsection )1* of section

11;>

t#ent &er cent of the ex&enses referred to in c"auses )A* to )%* of subsection )+* ofsection 11;>

fift &er cent of the ex&enses referred to in c"auses )B* to )J* of subsection )+* of

section 11;.

)+* Not#ithstanding anthing contained in subsection )1*,S

in the case of an em&"oer engaged in the business of hote", the !a"ue of fringe

benefits for the &ur&oses referred to in c"ause )* of subsection )+* of section11; sha"" be 4fi!e &er cent5 instead of 4t#ent &er cent5 referred to in c"ause

)c* of subsection )1*>

in the case of an em&"oer engaged in the business of construction, the !a"ue of fringebenefits for the &ur&oses referred to in c"ause )6* of subsection )+* of section

11; sha"" be 4fi!e &er cent5 instead of 4t#ent &er cent5 referred to in c"ause)c* of subsection )1*>

in the case of an em&"oer engaged in the business of manufacture or &roduction of&harmaceutica"s, the !a"ue of fringe benefits for the &ur&oses referred to in c"auses

)6* and )G* of subsection )+* of section 11; sha"" be 4fi!e &er cent5 instead of4t#ent &er cent5 referred to in c"ause )c* of subsection )1*>

in the case of an em&"oer engaged in the business of manufacture or &roduction of

com&uter soft#are, the !a"ue of fringe benefits for the &ur&oses referred to inc"auses )6* and )G* of subsection )+* of section 11; sha"" be 4fi!e &er cent5instead of 4t#ent&er cent5 referred to in c"ause )c* of subsection )1*>

in the case of an em&"oer engaged in the business of carriage of &assengers or goodsb motor car, the !a"ue of fringe benefits for the &ur&oses referred to in c"ause )K*

of subsection )+* of section 11; sha"" be 4fi!e &er cent5 instead of 4t#ent &ercent5 referred to in c"ause )c* of subsection )1*>


29/81

in the case of an em&"oer engaged in the business of carriage of &assengers or goodsb aircraft, the !a"ue of fringe benefits for the &ur&oses referred to in c"ause )I* of

subsection )+* of section 11; sha"" be ta8en as Ni".

C.2 Procedure for filing of return in respect of fringe benefits, assessment and pa+ment

of ta! in respect thereof

Return o! !ringe #ene!its

55;,D

in the case of an other em&"oer, the 31st da of Ou" of the assessment ear.

Payment o! !ringe #ene!it tax

55;,I. Not#ithstanding that the regu"ar assessment in res&ect of an fringe benefits isto be made in a "ater assessment ear, the tax on such fringe benefits sha"" be &aab"e in

ad!ance during an financia" ear, in accordance #ith the &ro!isions of section 11;O, inres&ect of the fringe benefits #hich #ou"d be chargeab"e to tax for the assessment ear

immediate" fo""o#ing that financia" ear, such fringe benefits being hereafter in thisCha&ter referred to as the 4current fringe benefits5.

Advance tax in respect o! !ringe #ene!its

55;,=


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&er cent of the !a"ue of the fringe benefits referred to in section 11;C, &aid or &aab"ein each =uarter and sha"" be &aab"e on or before the 1;th da of the month fo""o#ing

such =uarter:

Provided that the ad!ance tax &aab"e for the =uarter ending on the 31st da of /arch

of the financia" ear sha"" be &aab"e on or before the 1;th da of /arch of the saidfinancia" ear.

)3* here an assessee, has fai"ed to &a the ad!ance tax for an =uarter or #here thead!ance tax &aid b him is "ess than thirt &er cent of the !a"ue of fringe benefits &aid or

&aab"e in that =uarter, he sha"" be "iab"e to &a sim&"e interest at the rate of one &er centon the amount b #hich the ad!ance tax &aid fa""s short of, thirt &er cent of the !a"ue of

fringe benefits for an =uarter, for e!er month or &art of the month for #hich theshortfa"" continues.

1. ecommendations contained in this Guidance Note are intended to a&&" on" to items#hich are materia".

%uidance Note on $pecial Considerations in t+e Audit o! $mall Entities

INTRODUCTION

Auditing and Assurance (tandards )AA(s* 3earlier nown as Statements on StandardAuditing Practices )(AJs* contain basic &rinci&"es and essentia" &rocedures together

#ith re"ated guidance that a&&" to the audit of the financia" statements of anentit, irres&ecti!e of its si'e, its "ega" form, o#nershi& or management structure, or

the nature of its acti!ities. The Counci" of the institute recognises that audit of sma""entities gi!es rise to a number of s&ecia" considerations. This guidance is a

su&&"ement to, and not a substitute for, the guidance contained in the re"e!ant AA(

and ta8es account of the s&ecia" considerations re"e!ant to the audit of sma"" entities.6or the s&ecific re=uirements of AA(s, the auditor shou"d refer to the AA( concerned.This Guidance Note does not estab"ish an ne# re=uirements for the audit of sma""

entities nor does it estab"ish an exem&tions from the re=uirements of AA(s. A""

audits of sma"" entities are to be conducted in accordance #ith AA(s.

The ob@ecti!e of this Guidance Note is to describe the characteristics that are common"found in sma"" entities and indicate ho# the might affect the a&&"ication of AA(s.

This Guidance Note, thus, inc"udes:)a* discussion of the characteristics of sma"" entities> and

)b* guidance on the a&&"ication of AA(s to the audit of sma"" entities>

In determining the nature and extent of the guidance &ro!ided in this Guidance Note,

the Auditing and Assurance (tandards oard )AA(* has aimed to &ro!ide a "e!e" ofguidance that #i"" be of genera" a&&"icabi"it to a"" audits of sma"" entities and that

#i"" assist the auditor in exercising &rofessiona" @udgement #ith res&ect to thea&&"ication of AA(s. Ko#e!er, detai"ed guidance of a &rocedura" nature has not been

&ro!ided as the issue of such guidance ma undermine the &ro&er exercise of&rofessiona" @udgement in auditing.

Norma"", in the case of sma"" entities, the auditors &ro!ide ad!isor ser!ices onaccounting matters. It ma be noted that #ith a !ie# to ensure the inde&endence of


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auditor, the Counci" of the Institute of Chartered Accountants of India has c"arifiedthat the members are not &ermitted to #rite the boo8s of accounts of their auditee

c"ients. Therefore, a"though the auditor ma &ro!ide ad!isor ser!ices on accountingmatters, he shou"d refrain from #riting the boo8s of accounts of the auditee. A"so,

#hi"e &ro!iding the ad!isor ser!ices, the auditor must ensure that:)a* he does not "and in a situation #here there cou"d be conf"ict of interests and

dut>)b* the c"ient acce&ts the res&onsibi"it for the financia" statements> and)c* &ro!ision of ad!isor ser!ices does not resu"t into breach of an &ro!isions of the

Chartered Accountants Act, 199 and u"es and egu"ations framed thereunder.

The Characteristics of $mall Entities

The auditor of an entit ada&ts the audit a&&roach to the circumstances of the entit

and the terms of engagement. The audit of a sma"" entit differs from the audit of a"arge entit as documentation mabe sim&"e, and audits of sma"" entities are

ordinari" "ess com&"ex and ma be &erformed using fe#er assistants.

The meaning of sma"" entit in this context gi!es consideration not on" to the si'e of

an entit but a"so to its t&ica" =ua"itati!e characteristics. Puantitati!e indicators ofthe si'e of an entit ma inc"ude ba"ance sheet tota"s, re!enue and the number of

em&"oees, but such indicators are not definiti!e. Therefore, it is not &ossib"e to gi!e

an ade=uate definition of a sma"" entit so"e" in =uantitati!e terms.

6or the &ur&oses of this Guidance Note, a sma"" entit is an entit in #hich:)a* there is concentration of o#nershi& and management in a sma"" number of

indi!idua"s )often a sing"e indi!idua"1*> and)b* one or more of the fo""o#ing are a"so found:

U fe# sources ofincome and uncom&"icated acti!ities>U sim&"e and &ersona"i'ed record8ee&ing>

U "imited interna" contro"s together #ith the &otentia" for management o!erride ofcontro"s.

The =ua"itati!e characteristics described abo!e are not exhausti!e, the are notexc"usi!e to sma"" entities and sma"" entities do not necessari" dis&"a a"" of those

characteristics. 6or the &ur&oses of this Guidance Note, sma"" entities #i"" ordinari"dis&"a characteristic 7)a* and one or more of the characteristics inc"uded mentioned

at 7)b*. These characteristics need to be examined in e!er audit &eriod and if anentit doesnt dis&"a these characteristics in the &eriod, the entit #ou"d not be

categori'ed as sma"" entit in such &eriod.

Concentration of 'wnershi# and (anagement

(ma"" entities usua"" ha!e fe# o#ners, often there is a so"e &ro&rietor. /ano#nermanagers ado&t a hands on a&&roach to interna" contro" issues b &ersona""

exercising su&er!isor contro"s. The o#ner ma em&"o a manager to run thebusiness but in most cases is direct" in!o"!ed in running the business on a

datoda basis. As the &ro&rietor, the o#ner manager has a &ersona" interest insafeguarding the assets of the business, measuring its &erformance and contro""ing

its acti!ities, but ma be unab"e to di!ert "imited management time to such matters

as forma" interna" contro" &rocedures. Ko#e!er, the "ac8 of forma"it does not of itse"findicate circumstances gi!ing rise to a high ris8 of fraud or error, the auditors of a

sma"" entit ma8e their assessment of ris8 in the "ight of its &articu"ar circumstances.

This Guidance Note uses the term o#nermanager to indicate the &ro&rietors ofentities #ho are in!o"!ed in the running of the entit on a da to da basis. here
http://var/www/apps/conversion/tmp/scratch_3/%5Clft1%22http://var/www/apps/conversion/tmp/scratch_3/%5Clft1%22


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&ro&rietors are not in!o"!ed on a da to da basis, the term o#nermanager isused to refer to both the &ro&rietors, and to an managers hired to run the entit.

Few $ources of Income and )ncom#licated Activities

(ma"" entities t&ica"" ha!e a "imited range of acti!ities and often s&ecia"i'e in a sing"e

&roduct or se and o&erate from a sing"e "ocation.

?ncom&"icated acti!ities can ma8e it easier for the auditors to ac=uire, record and

maintain 8no#"edge of the business. In addition, in man sma"" entities, accounting&o&u"ations are often sma"" and easi" ana"sed> the a&&"ication of a #ide range of

audit &rocedures can often be straightfor#ard in such circumstances. 6or exam&"e,effecti!e &redicti!e mode"s for use in ana"tica" &rocedures can sometimes be

constructed.

$im#le *ecord+,ee#ing

/ost sma"" entities em&"o fe#, if an, &ersonne" #ho are so"e" engaged in record8ee&ing. Conse=uent", the boo8 8ee&ing functions and accounting records are often

sim&"e. ecord 8ee&ing ma be sim&"e, customised or &ersona"ised, #hich resu"ts ina greater ris8 that the financia" statements ma be inaccurate or incom&"ete. /an

sma"" entities outsource some of or a"" their record 8ee&ing. (ma"" entities often findit con!enient to use branded accounting soft#are &ac8ages designed for use on

&ersona" com&uter. (ma"" entities need to 8ee& sufficient accounting records tocom&" #ith an re"e!ant statutor or regu"ator re=uirements and to meet the

needs of the entit, inc"uding the &re&aration an audit of financia" statements.Therefore, the accounting sstem needs to be designed in such a manner so as to

&ro!ide reasonab"e assurance that:)a* a"" the transactions and other accounting information that shou"d ha!e been

recorded ha!e in fact been recorded>)b* assets and "iabi"ities recorded in the accounting sstem exist and are recorded at

the correct amounts> and)c* 6raud or error in &rocessing accounting information can be detected.

-imited Internal Controls

(i'e and economic considerations in sma"" entities mean that so&histicated interna"

contro"s are often neither necessar nor desirab"e, the fact that there are fe#em&"oees "imits the extent to #hich segregation of duties is &racticab"e. Ko#e!er,

for 8e areas, en in the !er sma"" entit, it can be &racticab"e to im&"ement somedegree of segregation of duties or other form of unso&histicated but effecti!e

contro"s. (u&er!isor contro"s exercised on a datoda basis b theo#nermanager ma a"so ha!e a significant beneficia" effect as the o#nermanager

has a &ersona" interest in safeguarding the assets of the entit, measuring its&erformance and contro""ing its acti!ities.

The o#nermanager occu&ies a dominant &osition in a sma"" entit. Theo#nermanagers direct contro" o!er a"" decisions, and the abi"it to inter!ene

&ersona"" at an time to ensure an a&&ro&riate res&onse to changing circumstances,are often im&ortant features of the management of sma"" entities. The exercise of

this contro" can a"so com&ensate for other#ise #ea8 interna" contro" &rocedures. 6orexam&"e, in cases #here there is "imited segregation of duties in the area of

&urchasing and cash disbursements, interna" contro" is im&ro!ed #hen theo#nermanager &ersona"" signs a"" che=ues. hen the o#nermanager is not

in!o"!ed, there is a greater ris8 that em&"oee fraud or error ma occur and not be


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detected.

hi"e a "ac8 of so&histication in interna" contro"s does not, of itse"f, indicate a high ris8

of fraud or error, an o#nermanagers dominant &osition can be abused:management o!erride of contro"s ma ha!e a significant ad!erse effect on the

contro" en!ironment in an entit, "eading to an increased ris8 of management fraudor materia" misstatement in the financia" statements. 6or exam&"e, the

o#nermanager ma direct &ersonne" to ma8e disbursements that the #ou"dother#ise not ma8e in the absence of su&&orting documentation.

The im&act of the o#nermanager and the &otentia" for management o!erride of interna"contro"s on the audit de&end to a great extent on the integrit, attitude, and moti!es

of the o#nermanager. As in an other audit, the auditor of a sma"" entit exercises&rofessiona" s8e&ticism. The auditor neither assumes that the o#ner manager is

dishonest nor assumes un=uestioned honest. This is an im&ortant factor to beconsidered b the auditor #hen assessing audit ris8, &"anning the nature and extent

of audit #or8, e!a"uating audit e!idence, and assessing the re"iabi"it of management

re&resentations.

CO**ENTAR/ ON T.EAPP&ICATION OFAUDITIN% AND A$$URANCE $TANDARD$

The commentar that fo""o#s &ro!ides guidance on the a&&"ication of AA(s to the auditof a sma"" entit. It is reiterated that this guidance is a su&&"ement to, and not asubstitute for, the guidance contained in the re"e!ant AA( and ta8es account of the

s&ecia" considerations re"e!ant to the audit of sma"" entities. 6or the s&ecificre=uirements of AA(s, the auditor shou"d refer to the AA( concerned. here a AA(

is, in &rinci&"e, a&&"icab"e to audit of financia" statements of sma"" entities and there

are no s&ecia" considerations a&&"icab"e to the audit of a sma"" entit, no guidance isgi!en in res&ect of that AA(.

AA$ ./ Documentation

Jaragra&h ; of AA( 3 states:The form and. content of #or8ing &a&ers are affected b matters such as:

U The nature of the engagement.

U The form of the auditors re&ort.U The nature and com&"exit of the c"ients business.

U The nature and condition of the c"ients records and degree of re"iance on interna"contro"s.

U The need in &articu"ar circumstances for direction, su&er!ision and re!ie# of #or8&erformed b assistants.

The auditor ma ha!e an inde&th understanding of the entit and its business, becauseof the c"ose re"ationshi& bet#een the auditor and the o#nermanager, or because of

the si'e of the entit being audited, or the si'e of the audit team and the audit firm.Ko#e!er, that understanding does not e"iminate the need for the auditor to maintain

ade=uate #or8ing &a&ers. or8ing &a&ers assist in the &"anning, &erformance,

su&er!ision and re!ie# of the audit, and the record the e!idence obtained to su&

&ort the audit o&inion.

The disci&"ine im&osed b the re=uirement to record the reasoning and conc"usions on

significant matters re=uiring the exercise of @udgment can often, in &ractice, add to

the c"arit of the auditors understanding of the issues in =uestion and enhance the=ua"it of the conc"usions. This is so for a"" audits, e!en in the case of a so"e

&ractitioner #ith no assistants.

Different techni=ues ma be used to document the entits accounting and interna"

contro" sstems, de&ending on their com&"exit. Ko#e!er in sma"" entities, the use of


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f"o#charts or narrati!e descri&tions of the sstem are often the most efficienttechni=ues. These can be 8e&t as &ermanent information and are re!ie#ed and

u&dated as necessar in subse=uent ears.

Jaragra&hs 11 V 1+ of AA( 3 &ro!ides exam&"es of the contents of #or8ing &a&ers.

These exam&"es are not intended to be used as a chec8"ist of matters to be inc"udedin a"" cases. The auditor of a sma"" entit uses @udgement in determining the contents

of #or8ing &a&ers in an &articu"ar case.

Ne!erthe"ess, the auditor of a "arge or a sma"" entit, records in the #or8ing &a&ers:

)a* the audit &"anning>)b* an audit &rogramme setting out the nature, timing, and extent of the audit

&rocedures &erformed>)c* the resu"ts of those &rocedures> and

)d* the conc"usions dra#n from the audit e!idence obtained together #ith thereasoning and conc"usions on a"" significant matters re=uiring the exercise of

@udgement.

In the audit of a sma"" entit, the nature and extent of the auditors &rocedures and,conse=uent", of the documentation needed, are "i8e" to be inf"uenced b thefo""o#ing characteristics of sma"" entities:

)a* (im&"e o#nershi& and management structures>)b* ?ncom&"icated acti!ities #ith fe# &roducts and ser!ices )and fe# "ocations*>

)c* 6e#, if an. Em&"oees>)d* (im&"ified accounting records>

)e* Jac8aged accounting soft#are> and)f* 6e#, if an, interna" contro"s.

AA$ 0/ The Auditor1s *es#onsibility to Consider Fraud and Error in an Audit offinancial $tatements

Jaragra&h 1F of AA( +, 0b@ecti!e and (co&e of the Audit of 6inancia" (tatements5

states as fo""o#s:5In forming his o&inion on the financia" statements, the auditor fo""o#s &roceduresdesigned to satisf himse"f that the financia" statements ref"ect a true and fair !ie#

of the financia" &osition and o&erating resu"ts of the enter&rise. The auditorrecognises that because of the test nature and other inherent "imitations of an audit,

together #ith the inherent "imitations of an sstem of interna" contro", there is anuna!oidab"e ris8 that some materia" misstatement ma remain undisco!ered. hi"e

in man situations the disco!er of a materia" misstatement b management maoften arise during the conduct of the audit, such disco!er is not the main ob@ecti!e

of audit nor is the auditors &rogramme of #or8 s&ecifica"" designed for suchdisco!er. The audit cannot, therefore, be re"ied u&on to ensure the disco!er of a""

frauds or errors but #here the auditor has an indication that some fraud or errorma ha!e occurred #hich cou"d resu"t in materia" misstatement, the auditor shou"d

extend his &rocedures to confirm or dis&e" his sus&icions.

Jaragra&h + of AA( )e!ised* states:

here &"anning and &erforming audit &rocedures and e!a"uating and re&orting theresu"ts thereof, the shou"d consider the ris8 of materia" misstatement in the financia"

statements resu"ting from fraud and error.5


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The &resence of a dominant o#nermanager is an im&ortant factor in the o!era"" contro"en!ironment as the need for management authori'ation can com&ensate for

other#ise #ea8 contro" &rocedures and reduce the ris8 of em&"oee fraud and error.Ko#e!er, this can be a &otentia" #ea8ness since is the o&&ortunit for management

o!erride of contro"s. The o#nermanagers attitude to contro" issues in genera" andto the &ersona" exercise of su&er!isor contro"s can ha!e a significant inf"uence on

the auditors a&&roach. The auditors assessment of the effect on such matters isconditioned b 8no#"edge of that &articu"ar entit and the integrit of its o#nermanager. /atters that auditors ma ta8e into account this assessment inc"ude the

fo""o#ing:

U hether the o#nermanager has a s&ecific identifiab"e moti!e )for exam&"e,de&endence of the o#nermanager on the success of the entit* to distort the

financia" statements, combined the o&&ortunit to do so.U hether the o#nermanager ma8es no distinction bet#een &ersona" and business

transactions.U hether the o#nermanagers "ifest"e is materia"" inconsistent #ith the "e!e" of

his or her remuneration )this inc"udes other sources of income #hich the auditor mabe a#are b com&"eting the o#nermanagers tax return, for exam&"e*.

U hether there are fre=uent changes of &rofessiona" ad!isors.

U hether the start date for the audit has been re&eated" de"aed or there areunex&"ained demands to com&"ete the audit in an unreasonab" short &eriod of time.U hether there are unusua" transactions around the ear end that ha!e a materia"

effect on &rofit.U hether there are unusua" re"ated &art transactions.

U hether the &aments of fees or commissions to agents and consu"tants a&&earexcessi!e.

U hether there are dis&utes #ith tax authoritiesU hether &arts of the detai"ed accounting records are una!ai"ab"e or ha!e been "ost

im&"ausib"e reasons>U hether there is a significant "e!e" of cash transactions #ithout ade=uate

documentation>

U hether there are man transactions #ithout ade=uate documentation.M hether numerous unex&"ained as&ects of audit e!idence )such as differences

bet#een the accounting records and third&art confirmations, or unex&ected resu"tsof ana"tica" &rocedures*>

U hether there is ina&&ro&riate use of accounting estimates>U hether the o#nermanager or 8e &ersonne" ha!e not ta8en annua" "ea!e for a

"ong &eriod of time.

U hether there is "ac8 of sufficient #or8ing ca&ita".U hether#ea8nesses re&orted ear"ier are continued.

U hether there is nonmaintenance of ear ending in!entor and stoc8 registers.

AA$;4 Audit Evidence

Jaragra&hs 1 to ; of AA( ; state:

51. (tatement on (tandard Auditing Jractices )AA(* 1, asic Jrinci&"es Go!erning anAudit5, states )&aragra&hs 1;17*:

The auditor shou"d obtain sufficient a&&ro&riate audit e!idence through the

&erformance of com&"iance and substanti!e &rocedures to enab"e him to dra#reasonab"e conc"usions therefrom on #hich to base his o&inion on the financia"

information.Com&"iance &rocedures are tests designed to obtain reasonab"e assurance that those

interna" contro"s on #hich audit re"iance is to be &"aced are in effect.(ubstanti!e &rocedures are tests designed to obtain e!idence as to the


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com&"eteness, accurac and !a"idit of the data &roduced b the accounting sstem.The are of t#o t&es:

)a* Tests of detai"s of transactions and ba"ances>

)b* Ana"sis of significant ratios and trends inc"uding the resu"ting en=uir of unusua"

f"uctuations and items.

$u!!icient Appropriate Audit Evidence

+. (ufficienc and a&&ro&riateness are interre"ated and a&&" to e!idence obtained fromboth com&"iance and substanti!e &rocedures. (ufficienc refers to the =uantum of audit

e!idence obtained> a&&ro&riateness re"ates to its re"e!ance and re"iabi"it. Norma"", theauditor finds it necessar to re" on e!idence that is &ersuasi!e rather than conc"usi!e. Ke

ma often see8 e!idence from different sources or of different nature to su&&ort the sameassertion.

3. The auditor shou"d e!a"uate #hether he has obtained sufficient a&&ro&riate audit

e!idence before he dra#s his conc"usions therefrom. The audit e!idence shou"d, in tota",enab"e the auditor to form an o&inion on the financia" information. In forming such an

o&inion, the auditor ma obtain audit e!idence on a se"ecti!e basis b #a of @udgmenta" orstatistica" sam&"ing &rocedures. 6or exam&"e, the auditor ma se"ect on" certain account

recei!ab"es for confirmation &ur&oses, or ma8e a se"ection of &ersonne" records for the&ur&ose of testing that changes in &aro"" rates ha!e been &ro&er" authorised.

. The auditors @udgement as to #hat is sufficient a&&ro&riate audit e!idence is inf"uencedb such factors as:

)a* The degree of ris8 of misstatement, #hich ma be affected b factors such as:

)i* The nature of the item>

)ii* The ade=uac of interna" contro">

)iii* The nature or si'e of the business carried on b the entit>

)i!* (ituations #hich ma exert an unusua" inf"uence on management>

)!* The financia" &osition of the entit.

)b* The materia"it of the item.

)c* The ex&erience gained during the &re!ious audits.

)d* The resu"ts of the auditing &rocedures, inc"uding fraud and error #hich ma ha!e beenfound.

)e* The t&e of information a!ai"ab"e.)f* The trend indicated b accounting ratios and ana"sis.

;. 0btaining audit e!idence from com&"iance &rocedures is intended to reasonab" assurethe auditor in res&ect of the fo""o#ing assertions:

Existence that the interna" contro" exists.

Effecti!eness that the interna" contro" is o&erating effecti!e".

Continuit that the interna" contro" has so o&erated throughout the

&eriod of re"iance.

In the audit of sma"" entities, there are &articu"ar &rob"ems in obtaining audit e!idence tosu&&ort the assertion of com&"eteness. There are t#o &rinci&a" reasons for this:

)a* the o#nermanager occu&ies a dominant &osition and ma be ab"e to ensure that


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some transactions are not recorded> and)b* the entit ma not ha!e interna" contro" &rocedures that&ro!ide documentar

e!idence that a"" transactions are recorded.

The auditor &"ans and conducts the audit #ith an attitude of &rofessiona" s8e&ticism. In

the absence of e!idence to the contrar, the auditor is entit"ed to acce&tre&resentations as truthfu" and records as genuine.

The auditor of a sma"" entit need not assume that there #i"" be "imited interna" contro"so!er the com&"eteness of im&ortant &o&u"ations such as re!enue. /an sma"" entities

ha!e some form of numerica"" based sstem to contro" the dis&atch of goods or the&ro!ision of ser!ices. here there is such a sstem to ensure com&"eteness, the

auditor ma obtain audit e!idence of its o&eration, b means of tests of contro", toassist in determining #hether contro" ris8 can be assessed at "ess than high in order

to @ustif a reduction in the extent of substanti!e testing.

here there are no interna" contro"s re"e!ant to the assertion, the auditor ma be ab"e

to obtain sufficient e!idence from substanti!e &rocedures a"one. (uch &roceduresma inc"ude the fo""o#ing:

U Com&aring recorded amounts #ith amounts ca"cu"ated on the basis of se&arate"recorded data, for exam&"e, goods issues recorded in &hsica" stoc8 records ma be

ex&ected to gi!e rise to sa"es income, and @ob sheets or time records ma be

ex&ected to gi!e rise to charges to c"ients.U econci"ing tota" =uantities of goods bought and so"d.

U Ana"tica" &rocedures.

U Externa" confirmation.U A re!ie# of transactions after the ba"ance sheet date.

AA$ 2/ *is3 Assessments and Internal Control

Jaragra&h + of AA( < re=uires that the auditor shou"d obtain an understanding of the

accounting and interna" contro" sstems sufficient to &"an the audit and de!e"o& an.

effecti!e audit a&&roach. The auditor shou"d use &rofessiona" @udgement to assessaudit ris8 and to design audit &rocedures to ensure that it is reduced to an

acce&tab" "o# "e!e".In+erent Ris1

Jaragra&h 1+ of AA( < re=uires that in de!e"o&ing the o!era"" audit &"an, the auditor

shou"d assess inherent ris8 at the "e!e" of financia" statements. In de!e"o&ing theaudit &rogramme, the auditor shou"d re"ate such assessment to materia" account

ba"ances and c"asses of transactions at the "e!e" of assertions made financia"

statements, or assume that inherent ris8 is high for the assertion, ta8ing intoaccount factors re"e!ant both to the financia" statements as a #ho"e and to the

s&ecific assertions. hen the auditor ma8es an assessment that the inherent ris8 isnot high, he shou"d document the reasons for such assessment.

In the audit of a sma"" entit, contro" ris8 is often assumed or assessed as high, at "eastfor certain financia" statement assertions. The assessment of inherent ris8 for thoseassertions ta8es on a &articu"ar significance, as it has a direct im&act on the extent

of substanti!e &rocedures. There are difficu"ties in the assessment of the inherentris8 of a sma"" entit, for exam&"e there ma be increased ris8 as a resu"t of the

concentration of o#nershi& and contro". Ko#e!er, the auditors assessment ofinherent ris8 in a sma"" entit de&ends on its &articu"ar characteristics> carefu"

assessment of inherent ris8 for materia" financia" statement assertions, rather thanan assum&tion that it is high, ma enab"e the auditor to conduct a more efficient and


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effecti!e audit.

Control Ris1

Jaragra&h ++ of AA( < re=uires that after obtaining an understanding of the accountingsstem and interna" contro" sstem, the auditor shou"d ma8e a &re"iminar

assessment of contro" ris8, at the assertion "e!e", each materia" account ba"ance or

c"ass of transactions.

An understanding of the contro" en!ironment is essentia" to the understanding of contro"ris8. The auditor considers the o!era"" inf"uence of the o#nermanager and other 8e

&ersonne". 6or exam&"e, the auditor considers #hether the o#nermanager dis&"asa &ositi!e contro" consciousness and considers the extent to #hich the

o#nermanager and other 8e &ersonne" are acti!e" in!o"!ed in datodao&erations.

After obtaining an understanding of the accounting and interna" contro" sstems, theauditor ma8es a &re"iminar assessment of contro" ris8, at the assertion "e!e", for

each materia" account ba"ance or c"ass of transactions. (ubstanti!e &rocedures mabe reduced if re"iance on these contro"s is #arranted after in!estigation and testing.

Ko#e!er, man interna" contro"s re"e!ant to "arge entities are not &ractica" in thesma"" entit, and as a resu"t it ma not be &ossib"e to re" on interna" contro" to

detect fraud or error. 6or exam&"e, segregation of duties ma be se!ere" "imited insma"" entities because accounting &rocedures ma be &erformed b fe# &ersons #ho

ma ha!e both o&erating and custodia" res&onsibi"ities. (imi"ar", #hen there are fe#em&"oees, it ma not be &ossib"e to set u& a sstem of inde&endent chec8ing of

their #or8.

Inade=uate segregation of duties and the ris8 of error ma, in some cases, be offset b

other contro" &rocedures such as the exercise of strong su&er!isor contro"s b theo#nermanager b means of direct &ersona" 8no#"edge of the entit and

in!o"!ement in transactions. Ko#e!er this, in itse"f, ma introduce other ris8s such asthe &otentia" for management o!erride and fraud. Jarticu"ar difficu"ties inc"ude the

&ossib"e understatement of income b the nonrecording or misrecording of sa"es. Incircumstances #here segregation of duties is "imited and e!idence of su&er!isor

contro"s is "ac8ing, the audit e!idence necessar to su&&ort the auditors o&inion onthe financia" statements ma ha!e to be obtained entire" through the &erformance

of substanti!e &rocedures.

The auditor of a sma"" entit ma decide, based on the auditors understanding of the

accounting sstem and contro" en!ironment, to assume that contro" ris8 is high#ithout &"anning or &erforming an detai"ed &rocedures )such as tests of contro"s* to

su&&ort that assessment. E!en #here there a&&ear to be effecti!e contro"s it ma bemore efficient for the auditor to confine audit &rocedures to those of a substanti!e

nature.

The auditor ma8es management a#are of materia" #ea8nesses in the design or

o&eration of the accounting and interna" contro" sstems that ha!e come to theauditors attention. ecommendations for im&ro!ement ma a"so be made in this

communication. (uch recommendations are &articu"ar" !a"uab"e for the

de!e"o&ment of the sma"" entits accounting and interna" contro" sstems.

Detection Ris1

Jaragra&h 3 of AA( < )e!ised* states:

The auditor shou"d consider the assessed "e!e"s of inherent and contro" ris8s indetermining the nature, timings and extent of substanti!e &rocedures re=uired to


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reduce the audit ris8 to an acce&tab" "o# "e!e". In this regard the auditor #ou"dconsider:

)a* The nature of substanti!e &rocedures, for exam&"e, using tests directed to#ardinde&endent &arties outside the entit rather than tests directed to#ard &arties or

documentation #ithin the entit, or using tests of detai"s for a &articu"ar auditob@ecti!e in addition to ana"tica" &rocedures>

)b* The timing of substanti!e &rocedures, for exam&"e, &erforming them at &eriodend rather than at an ear"ier date> and)c* The extent of substanti!e &rocedures, for exam&"e, using a "arger sam&"e si'e.

The auditor uses the assessments of inherent and contro"s ris8 to determine the

substanti!e &rocedures that #i"" &ro!ide the audit e!idence to reduce detection ris8,

and therefore audit ris8, to an acce&tab"e "e!e". In some sma"" entities, such as those#here most transaction are for cash and there is no regu"ar &attern of costs and

margins, the a!ai"ab"e e!idence ma be inade=uate to su&&ort an un=ua"ified o&inion

on the financia"